Six steps to completing a management buyout

MBO, First West Capital, Robert Napoli

One of the best investments you can make is buying the business you work for. Here is how to do it.

Owning your own business gives you control over your future; the business is yours to grow and reap the rewards from your hard work. Over the next five to ten years managers and management teams will see their bargaining power increase as retiring owners seek to exit. There are simply more baby boomers than people in generation X. A management buyout (MBO) can be a viable succession plan for businesses of all sizes.

An MBO is where the management team buy the company they work for from the current owner using the security and cash flows of the company itself to obtain the capital required. Management invests their equity, akin to a down payment on a home, and borrows and/or seeks equity financing from institutional lenders and investors for the rest.

MBO’s present several advantages for the buyer; it minimizes investment risk, as you have inside information on the business already, and the rates of return on equity can be far higher than other assets. There are additional benefits from the use of leverage, and tax advantages from owning a business. You should have a plan to grow the business, perhaps double it in size, to make it worthwhile.

The most important advantage of an MBO is it puts you in the driver’s seat. Here are six steps needed to successfully complete an MBO:

1. Build your management experience and credibility

Work with the owner to transition the management of the various key functions to you and/or your team. By proving you can run the company you will validate your worth to outside investors and increase your bargaining power with the vendor when it comes time to sell the company.

2. Position yourself to become an owner

Building rapport and trust with the owner positions you as a front runner to buy the business. The owner likely cares a great deal about the business’ legacy and its employees, so demonstrate that under your management the business can run independently, allowing the owner to gradually step back and find new purposes in life that pull them in a new direction. While you are managing the business, do your due diligence and understand all the risks ownership will entail. Get your significant other on board, as investing considerable time and money is often a family decision.

3. Approach an offer

Businesses only ever change hands when the owner is ready to let go. You can get a sense of the owner’s fears, motivations and concerns through open dialogue – it may be a good idea to initiate discussions with the help of a trusted outside adviser. The owner will need to feel comfortable they are getting the right deal, that they will be okay ceding control, and that their next move will be fulfilling. Every situation is unique, but be prepared for challenges around seller motivation.

4. Negotiate from a position of strength

The owner wants to obtain the best possible price and receive fair value for the business. The MBO will need to compete effectively with other options, such as sale to private equity or a strategic buyer – therefore it helps if the management team is a key component of the succession plan. If your absence from the business would create a problem for a future buyer, your negotiating strength improves. This is not to say you can hold all the cards or force the owner into a decision, however it may help in putting you into a preferred position to be chosen as the successor.

5. Finance the purchase

Financing for the MBO can come from a combination of conventional lending sources, subordinated debt, private investors, the vendor and your own equity. First West Capital offers a management buyout package that can include loans and/or equity finance to enable management teams to buy businesses up to $20 million in value. We look for management to invest a meaningful amount of equity, relative to their personal net worth, and we provide financing for the rest. We help management achieve 100% ownership over time by providing an option to buy us out.

6. Close the deal

An important transaction like this requires expert advice. We recommend having a tax adviser, a corporate finance adviser and a corporate lawyer to help negotiate and structure the deal. This team will prove essential to keeping the deal on track, documenting it properly and avoiding pitfalls.

A management buyout is not for the faint of heart. But if you have dreamed of running your own show, and reaping the rewards of ownership, it could be your best chance at achieving your ambitions.

This article first appeared in Business in Vancouver’s Feb.7th issue.